Miles on Money: Can congress cut U.S. debt?

When you come down to it, lenders look for just two simple things from borrowers: the willingness and the ability to repay their debt.

As a significant owner of U.S. government securities on behalf of our clients, and as a citizen, I have given much thought in recent days to how our country stacks up on both measures.

To begin, I confess that it still feels odd to do ongoing analysis of whether the United States will make good on its debt. When I was in finance class many years ago, the first step in measuring the adequacy of return from a given investment was to reference the risk-free rate on comparable-term Treasury securities. Back then, we didn’t spend any time evaluating the creditworthiness of the United States. “Full faith and credit” – at least when given by the government of the United States of America – was an ironclad guarantee.

Now that the question of whether to raise the debt ceiling – that is, whether we will choose to repudiate the financial commitments we have already made – has become an accepted tool of political brinkmanship, the world is a different place. Fitch Ratings Inc. stated it plainly Oct. 15, when it placed U.S. government debt on “Ratings Watch Negative” and said “Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default.”

Of course, we now know that the sky didn’t fall. Late on Oct. 16, the president signed into law the Continuing Appropriations Act of 2014, reopening the federal government and lifting the debt ceiling. An optimistic take on this resolution would highlight that the U.S. government has still, despite all, never defaulted on its debts.

But a more sober assessment of the situation must also acknowledge the continuing insistence of Congress that it remain the center of the financial universe. As Mohamed El-Erian, CEO of the global investment firm PIMCO, has noted, this latest budget deal is simply a temporary cease-fire between warring factions. It funds the government only until Jan. 15, 2014, and suspends the debt ceiling until Feb. 7. In the meantime, members of a congressional conference committee charged with working out a budget compromise by mid-December have already started downplaying expectations that a deal can be reached.

Fortunately, there is some good news: Despite dramatic growth in the federal debt since 2008, the ability of the United States to repay its debt remains very strong. According to a report released by the Congressional Budget Office in September, if current laws were unchanged, by 2018 the federal debt would decline to 68 percent of gross domestic product from its current level of 73 percent. So near term, no action is needed. Longer term, however, thanks to increasing interest costs and growing spending for Social Security and health care programs, the debt level would begin to rise, increasing to 108 percent of GDP by 2038.

To be clear, a debt level equal to 108 percent of GDP is unacceptably high, so the current course is unsustainable. But the CBO report goes on to describe how a combination of spending and tax changes that save $2 trillion dollars over the next decade would be enough to hold federal debt at current levels through 2038. Reducing annual deficits starting at $145 billion next year would arrest the growth of our debt as a percentage of GDP. Can we do that? Well, $145 billion is less than 5 percent of projected government outlays in the current fiscal year. So, it’s doable.

Of course, further deficit reductions won’t be easy. Very little of the federal government’s budget is discretionary at this point, so reforms will be needed. And reaching agreement will be challenging. Some will want more taxes as well as expense cuts, while others will oppose tax increases. And there is a legitimate argument over whether immediate deficit reductions will harm our fragile economic recovery.

The point is that the United States is not beyond the point of no return with regard to managing our debt.